Obama's debt commission report: 4 flash points

By Jeanne Sahadi, senior writerNovember 30, 2010: 5:13 AM ET

NEW YORK (CNNMoney.com) -- Get ready for some heated rhetoric about how to contain the unsustainable national debt.

The spark will be lit by President Obama's bipartisan debt commission, which is set on Wednesday to vote on a final set of recommendations. That report will be an amended version of a plan put out three weeks ago by the panel's co-chairmen, Erskine Bowles and Alan Simpson.

What you hear this week is just the start of a long national conversation. Next year, Obama and Congress will attempt to turn talk into policies.

But for now, here's a look at just four flash points likely to dominate the reaction to the commission's report: Social Security, defense spending, the mortgage interest deduction and the spending vs. taxes debate. (Take the CNNMoney deficit quiz)

Social Security

The original Bowles-Simpson draft calls for a two-year increase in the full and early retirement ages.

The increase would happen gradually over the next 65 years, and workers unable to work past the current early retirement age of 62 would be offered "hardship exemptions." The plan, however, doesn't define the hardship exemption criteria.

Increasing the retirement age has been a non-starter with liberals. They say it's effectively a benefit cut on the middle class and low-income workers, who rely on Social Security the most and who may not be able to stay in their jobs as long as the new retirement ages would require.

For the left, the preferred way to shore up Social Security's long-term shortfall is to increase the amount of taxes paid into the program.

The original Bowles-Simpson plan calls for a bump in revenue too, but its proposal isn't as broad and won't take effect as quickly as liberals would like.

Bowles-Simpson calls for the cap on earnings subject to the Social Security payroll tax -- currently $106,800 -- to be raised so that within 40 years the tax would apply to 90% of total earnings in the country. That's how much income was subject to the tax in 1983, the last time Congress reformed Social Security.

A more turbocharged version of that proposal was put forth in a report Monday from the liberal organizations Demos and the Economic Policy Institute as well as the Century Foundation.

The groups recommended raising the cap to capture 90% of earnings for the half of the payroll tax paid by employees, and eliminating the cap altogether on the half paid by employers.

The plan doesn't specify when such a change would go into effect.

"The economic situation should dictate the timing. You shouldn't start any major austerity plan before the economy is fully recovered," said John Irons, EPI's research and policy director.

Defense spending

There is growing support for cutting defense spending to reduce the deficit.

Defense spending accounts for roughly 20% of the federal budget. Indeed, the United States spends more on defense than any other country, and about five times more than China, which ranks second on the list.

It's easy enough to find consensus on the notion that some defense spending is wasteful, ineffective or outdated.

But there's still deep disagreement between the left and the right -- and among Republicans themselves -- on whether the money that could be saved should be put toward deficit reduction or used to reinvest in other areas of defense.

Mortgage interest deduction

The most popular deduction for homeowners -- and the lobbyist-heavy real estate industry -- is also one of the most expensive for federal coffers, costing more than $100 billion a year in forgone revenue.

And the mortgage interest deduction is always a key topic in any discussion about reducing tax breaks -- which cost more than $1 trillion every year and which many tax experts say are really spending in disguise for targeted industries and segments of the population.

The deduction could be limited in a number of ways.

One approach is to cap the size of loans on which the tax break can be used. For instance, it could apply only to the first $500,000 of a loan, about half of what counts today.

Another way to modify the mortgage break is to convert it from a deduction to a credit. That would make it available to more taxpayers -- currently, only those who itemize can take the deduction. But a mortgage credit would be less valuable to high-income homeowners.

Spending cuts vs. tax increases

Ultimately, the most basic divide in the debate over how to reduce the debt comes down to this: How heavily should policymakers rely on spending cuts versus increases in tax revenue -- the latter resulting from new taxes, higher rates or a reduction in tax breaks.

There are notable exceptions, but a large number of Democrats want tax increases to do the heavy lifting, while most Republicans would prefer spending cuts carry the day.

Whatever the final split, the endgame is to stabilize debt as a percentage of the economy, and then to reduce it over time.

Today, the country's accumulated debt is roughly 60% of GDP. Barring any changes, it's slated to top 87% by 2020 and approach 200% by 2035, according to the Congressional Budget Office.